Pension Funds Strongest Since 2011 Fuel Gilt Demand: U.K. Credit

A sale last week of long-dated U.K. inflation-linked bonds, typically owned by pension funds, drew record demand and gilts are outperforming Treasuries and Japanese government debt this year. Photographer: Chris Ratcliffe/Bloomberg

Feb. 4 (Bloomberg) -- Pension funds in the strongest
financial position for 2 1/2 years are helping U.K. government
bonds reverse the deepest losses since 1994.

Bolstered by the best stock performance in four years and a
surge in bond yields, pension funds have enough assets to cover
98 percent of their future commitments, the highest level since
June 2011, according to the Pension Protection Fund. It means
retirement plans can add to bond holdings as they seek
predictable revenue and reduced vulnerability to price swings
and inflation.

A sale last week of long-dated U.K. inflation-linked bonds,
typically owned by pension funds, drew record demand and gilts
are outperforming Treasuries and Japanese government debt this
year. While analysts and investors predict rates on developed-market bonds will rise as the Federal Reserve pares asset
purchases, some say demand from pension funds will limit the
increase.

Gilt Returns

Gilts returned 2.1 percent in January after falling 4.25
percent in 2013, Bank of America Merrill Lynch indexes show.
German bunds gained 2.2 percent, while U.S. Treasuries added 1.6
percent and Japanese bonds climbed 0.8 percent.

U.K. bond yields rose to 2.40 percent on an aggregate basis
this week from a record low of 1.52 percent in August 2012, the
indexes show. The yield reached 2.61 percent in December, the
highest in 28 months, as the Fed announced plans to start
reducing the amount of bonds it buys and accelerating growth in
the U.K. prompted investors to bet the Bank of England could
start raising interest rates as soon as this year.

The rate on 10-year U.K. government bonds will rise to 3.40
percent in the fourth quarter from 2.71 percent at 2:23 p.m.
London time today, according to the median forecast of 24
analysts in a Bloomberg survey.

Liability Matching

“We do expect bond yields in the European market to rise
because of the Fed policy and because of the growth outlook,”
said Lukas Daalder, a money manager at Rotterdam-based Robeco
Groep NV, which has $260 billion in assets. “But we can’t
envisage yields rising substantially because the recovery
remains weak. And there is always demand for bonds from those
seeking to match liabilities. As a general rule, they are
unlikely to underweight government bonds.”

Pension funds use government yields as a discount rate to
measure future obligations, meaning the surge last year helped
them to reduce their liabilities. Stock gains also improved
their funding levels, allowing them to buy bonds to meet their
long-term liabilities. The FTSE 100 Index, which jumped 14
percent in 2013, is 4.4 percent lower this year.

According to JPMorgan Chase and Co., pension-fund demand
will cap gilt yields as Fed tapering damps the appetite for
fixed-income assets. The bank estimates that global bond supply
will outstrip demand by $200 billion this year, compared with
$140 billion in 2013.

“As the gap between liability and assets narrows, pension
funds have a strong incentive to lock in the improvement in the
funding gap,” said Nikolaos Panigirtzoglou, global market
strategist at JPMorgan in London. “Bond demand from pension
funds and insurance companies should increase as bond yields
rise. This will help to provide a cushion from the impact of the
Fed’s tapering.”